As America’s economy reopens, we’re seeing higher inflation
rates, and this unwelcome surge should prompt retirees to consider the threat
it could pose to their financial security.
The 5.4% rise in the consumer price index in the last year
marked the highest inflation in almost 13 years. If you remember the soaring,
double-digit inflation rates of the 1970s, you may be worried now. However, even
if inflation never reaches those levels again, you still need to consider the
eroding effects it has on your nest egg over the long haul.
How Much Will Your Money be Worth in 10 or 20 Years?
Even moderate inflation can have a significant effect on a retiree’s
savings. The Federal Reserve’s target inflation rate is 2%, but the Fed has
said it will allow inflation to rise above that mark for some time. Let’s take
a look at how an average annual inflation rate of 3% over the next 20 years
would impact your finances.
If you needed $60,000 for your first year of retirement, in
20 years you would require $108,366.67 to match today’s purchasing power of
$60,000. Another way to look at it: At 3% annual inflation, that initial
$60,000 would be worth only $33,220.55 in 20 years.
You need to factor inflation into your retirement plan
because you can expect that everyday items, travel and other expenses will
continue to rise in cost. Inflation erodes the value of savings and will
continue to do so after you retire. Considering the near-zero interest rates of
savings accounts, retirees who are living off their savings are especially
vulnerable to high inflation. Therefore, it’s important to assess your
investment strategy and retirement income plan to see if you’re protected
against inflation for the long term.
Social Security Is Not Keeping up
The Senior Citizens League estimates that the average Social
Security benefit has lost almost a third of its buying power since 2000 because
benefit increases have not kept up with the increasing cost of prescription
drugs, food and housing. This has occurred despite yearly cost-of-living
adjustments (COLAs) for Social Security benefits that are meant to make benefit
amounts keep up with inflation.
Social Security beneficiaries saw a relatively high cost-of-living
adjustment (COLA) of 2.8% in 2018 (for the 2019 benefit year). In 2020, they
saw a 1.3% increase (for the 2021 benefit year). In some years, the COLA
adjustment has been nonexistent or practically so. It was 0.3% for 2016 and 0%
for 2015. Lawmakers have proposed changing how COLAs are calculated to make
benefit increases better reflect the price increases older Americans see.
Consider what would happen if all your retirement income
lost a third of its value over the course of 20 years. Would that scenario make
it more likely that you will run out of money?
What can You Do?
So, how can you know how much income you will need in retirement
when inflation insists on complicating the situation? Here are some things to
keep in mind:
First, consider any fixed-income sources in retirement
that will not likely keep pace with inflation. In the process, consider how
much interest you are earning from money in a savings account or CD. It’s
unlikely that we will see a substantial interest rate hike in the next few
years, so be prepared to continue earning little interest. It’s important to
assess your investment strategy and retirement income plan to see if you’re
protected against inflation for the long term.
Next, calculate how much your nest egg is right now.
As you do, factor in inflation over the next 10, 20 and 30 years. Consider that
while overall inflation rates may fall from what they are now, that might not
be true for some of the specific goods and services that could take a large
chunk of your income, such as energy, food or health care and long-term care
costs.
Consider whether your current investment strategy will
need to change once you retire. You may want to contemplate a strategy that
continues to grow your money in retirement, so when transitory events like
inflation hit, you’re covered. Foundationally, a solid plan ensures that your
purchasing power needs are always met. Some people may need to take on less
investment risk once they near and reach retirement. However, having the right
risk asset allocations for your particular situation could help combat the
eroding effects of inflation on your nest egg over the course of your
retirement.
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